16th Pacific Rim Real Estate Society Conference
Wellington 2010
16th Pacific Rim Real Estate Society Conference
Wellington 24th – 27th January 2010
REIT Investment Decision Making:
A Multi Step Process?
Professor David Parker
University of South Australia
Visiting Fellow, University of Ulster
______________________________________________________________________________
Keywords:
REIT, investment, decision making, strategy, tactical asset allocation
________________________________________________________________________
Abstract:
Real estate investment trusts (REITs) are multi-billion dollar property investment
vehicles, well established in various countries around the world. Despite their size and
prevalence, relatively little research has been undertaken into the property investment
decision making processes adopted by REITs.
With the aim of identifying whether the property investment decision making process is
sequential and, if so, the nature and extent of the sequence, a review of the literature
addressing generalised frameworks for the property investment decision making process
was undertaken. Following analysis of the literature reviewed, a six phase approach to
property investment decision making is hypothesized and then reconciled to the literature
reviewed.
Further empirical research is proposed to determine the appropriateness of classification
into phases and to specify the content of each phase, together with determining the extent
of difference, if any, between generalized property investment decision making
frameworks for institutions and those adopted by REITs.
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1.0
Introduction
Real estate investment trusts (REITs) are now well established as a property investment
vehicle around the world. In February 2008, 436 REITs existed in eighteen countries
including 152 in the US, 50 in France, 18 in Singapore and one in Italy with a global
REIT market capitalization of US$661bn, relative to a global stock market capitalization
of US$38,886bn, as illustrated in Figure 1 (Radanovic and DeFrancesco (2008)).
Global REIT Market Capitalisation – February 2008
Source: Radanovic and DeFrancesco (2008)
Figure 1
However, the global financial crisis has been particularly severe for REITs with the
Australian REIT index falling around 75% from a zenith in mid 2007 to a nadir in early
2009. Following the previous stock market and property market collapse, Roulac (1994)
noted:
“Extraordinary financial losses and market disruption in the late
1980s and early 1990s are eloquent, if damning, testimony to the
proposition that the quality of many real estate decisions is less
than distinguished.”
which could equally be applied to events of the recent past.
While REITs invest billions of dollars in property, relatively little research has been
undertaken into the decision making processes that drive such investment. The following
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seeks to review the literature concerning property investment decision making in general
and for REITs in particular to identify whether the process is contended to be sequential
and, if so, the nature and extent of the sequence.
Section 2.0 comprises a survey of the literature concerning generalized property
investment decision frameworks. Section 3.0 then analyses the literature to identify
whether the process is sequential with Section 4.0 considering the nature and extent of
the sequence. Section 5.0 briefly considers the role of judgment and section 6.0 draws
conclusions from the analysis of the literature and identifies areas for further research.
2.0
Literature Survey
Following a keyword search, the literature concerning property investment decision
making in general and by REITs in particular was found to principally comprise
textbooks, refereed journal papers and industry or professional journal papers. A further
search of conference proceedings yielded only a very limited contribution from
conference papers, which generally had been subsequently published.
In overview, the textbooks were found to address multiple aspects of the property
investment decision making process but in limited detail, whereas the journal papers
tended to focus on an individual aspect of the process in considerable detail with three
exceptions identified. Accordingly, for the purposes of this survey, it is proposed to
consider the contribution of the textbooks and the three specific journal papers that
address multiple aspects of the property investment decision making process.
Significantly, the survey of the literature found neither textbooks nor journal papers that
solely address the property investment decision making process in the context of REITs.
Certain text books consider investment decision making in the property sector generally
including reference to REITs (see, for example, Wurtzebach et al (1994) or Geltner et al
(2007)), whilst others consider REITs but with limited, if any, reference to investment
decision making (see, for example, Block (2002) or Garrigan and Parsons (1997)).
Accordingly, it may be contended that the literature surveyed focuses primarily on
individual property investment decision making and institutional property investment
decision making, but with the nature of the institution undefined. Institutions may take a
range of forms including large and small, long term superannuation funds or short term
development funds, unlisted entities or listed entities and so forth, such that a generalized
property investment decision making framework is, by definition, generalised.
While REITs may be distinguished from individuals from the viewpoint of decision
making, they may be expected to have greater similarity to institutions. Such aspects as
fiduciary responsibility may be common between REITs and various forms of institutions
though the requirements of stock exchange listing, such as continuous disclosure, may
differ between REITs and unlisted institutions. It may, therefore, be anticipated that the
REIT property investment decision making process may have much in common with that
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of institutions generally but vary to reflect the differences between the REIT environment
and that of institutions generally.
As noted by Roberts and Henneberry (2007), the textbook and journal paper authors
generally approach the property investment decision making process as a normative
model, being an exercise in rational analysis with a dependence on the use of rational
evaluation tools such as modern portfolio theory and the capital asset pricing model to
inform decision making.
Among the US texts, Pyhrr et al (1989) propose a ten step process including:
1. determine the investment strategy;
2. generate alternatives;
3. analyse property using basic financial feasibility models;
4. negotiate basic terms with sellers;
5. do detailed feasibility research;
6. complete financial and tax structuring;
7. perform a DCF analysis;
8. final negotiations and closing;
9. manage the property; and
10. terminate the property.
Jaffe and Sirmans (2001) propose a five step process as a series of organised and coordinated steps that can be followed to systematically analyse potential real estate
investments:
1.
2.
3.
4.
5.
identify goals, objectives and constraints;
analyse the overall investment environment;
forecast expected future benefits and costs;
apply appropriate decision making criteria; and
accept or reject the investment.
Pagliari (1995) considers the portfolio management process as a six step process,
comprising:
1.
2.
3.
4.
5.
6.
investor’s objectives and constraints;
real estate market conditions and expectations;
target portfolio determination;
portfolio strategy determination;
portfolio monitoring; and
portfolio performance measurement.
Roulac (1994) observes that the real estate decision process is inherently generic to any
decision involving major capital commitments, having close parallels to the corporate
capital budgeting process and proposing four sequential critical phases:
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1. structure (being the specification of the decision process which, if not
explicitly articulated, may be implicit leading to ambiguity and sub-optimal
decisions);
2. opportunity (being the initiation of an investment opportunity from
organizational initiative or third party presentation);
3. assessment (being the evaluation of the opportunity); and
4. decision (being the authority to make the decision and subsequent
implementation).
Significantly, Roulac (1994) notes that decision making in an institutional setting, such as
exists in the publicly listed REIT environment, should emphasise process with each phase
being undertaken separately, rather than combined, by distinct parties.
Among the UK texts, Baum (2002) proposes a six step process comprising:
1.
2.
3.
4.
5.
6.
determination of ideal portfolio structure;
identification of target sub-sectors;
sourcing new stock from the market;
appraisal;
modeling of portfolio impact; and
acquisition process.
Brown and Matysiak (2000) note four distinct activity groups in the capital budgeting
process, being:
1.
2.
3.
4.
screening;
evaluation;
implementation; and
auditing.
Hartigay and Yu (1993) propose the investment decision making process to consist of
five steps, being:
1. definition of objectives and specific goals;
2. search for a set of alternative investment projects which promise to achieve
the objectives and goals set;
3. evaluate, compare and rank the alternatives in terms of the quantified
expectations of risk and return;
4. choose the most satisfactory alternative; and
5. at a later date, evaluate the consequences of the decisions taken earlier, draw
conclusions, revise goals and criteria.
Among the published journal papers, Farragher and Savage (2008) refer to good real
estate investment decision making being based on the application of experience, good
judgment and creativity in a nine step decision making process:
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1.
2.
3.
4.
5.
6.
7.
8.
9.
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setting strategy;
establishing risk/return goals;
searching for investment opportunities;
forecasting expected returns;
evaluating forecast returns;
assessing and adjusting for risk;
decision making;
implementing accepted proposals; and
auditing operating performance.
Farragher and Kleiman (1996) suggest a seven step process for real estate investment
decision making, comprising:
1.
2.
3.
4.
5.
6.
setting strategy – strategic analysis;
establishing risk / return objectives;
forecasting expected costs and returns;
assessing investment risk;
making risk adjusted evaluations of the forecast costs and returns;
implementing accepted proposals including due diligence, formal feasibility
analysis, independent appraisal and formal implementation plan; and
7. post audit review of the performance of operating investments.
Based on their analysis and combination of various normative models proposed in the
literature, Roberts and Hennebery (2007) propose a ten step composite model of the
property investment decision making process:
1. setting of initial (property) investment goals and decision criteria;
2. formulation of a fully defined decision making strategy (relating to portfolio
structure and performance);
3. search (for suitable properties);
4. information input (including analysis of market conditions);
5. prediction of outcomes (return and risk at portfolio and property levels);
6. application of decision criteria;
7. trade off (between properties);
8. project screening (of properties);
9. investment selection; and
10. negotiation, deal resolution and post investment activity.
In overview, regardless of whether the property investment decision making process is
that of an individual or an institution, that literature reviewed would appear to indicate
not only considerable similarities but also considerable differences for further analysis.
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3.0
Literature Analysis
The literature reviewed clearly indicates a generalised framework for property investment
decision making, with considerable similarities between authors. Based on a review of
the literature, Roberts and Hennebery (2007) helpfully propose one possible summary
framework for property investment decision making that comprises ten steps
incorporating most, if not all, of the elements cited by other authors. Usefully, Roberts
and Hennebery (2007) in common with Brown and Matysiak (2000) adopt the approach
of grouping elements within the property investment decision making process as activity
bundles such as “search” or “evaluation”.
The principal similarity in the literature may be contended to be that the property
investment decision making process is sequential. With the possible exception of Roulac
(1994), each author has a common starting point, comprising some form of strategic
element, though the end point varies with some authors stopping at the point of property
investment and others going on to include post investment activities of various forms.
However, while each author sees the investment decision making process as a series of
steps in a linear process, that which happens between the common starting point and end
point of the property investment decision making process varies between authors not only
in the number of steps but also in the names given to the steps and the activities
undertaken within each step.
Accordingly, based on that literature reviewed, it may be contended that the property
investment decision making process is sequential and linear but that the nature and extent
of the process differs between authors. Similarly, it may be contended that the
generalised framework proposed in the literature may apply to individuals and to
institutions though the literature does not specifically consider application to REITs to the
extent that they differ from institutions generally.
It is, therefore, proposed to hypothesise a simplified property investment decision making
framework, based on the literature reviewed, that is capable of application by REITs
given their specific characteristics and that may be tested by subsequent empirical
analysis.
4.0
Nature and Extent of the Sequence
While the investment decision making process may be contended to be sequential and
linear in nature, it may also be circular in extent. Hartigay and Yu (1993) refer to drawing
conclusions and then revising goals and criteria and Pagliari (1995) refers to linking
results back to inputs, which may be contended to indicate a circular process.
Pagliari (1995) refers to “the dynamics of the real estate portfolio management process”
and succinctly summarises the activities therein graphically, as reproduced in Figure 2.
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Real Estate Portfolio Management Process
Source: Pagliari (1995)
Figure 2
Pagliari (1995) clearly echoes Hartigay and Yu (1993) with the activity of “portfolio
performance measurement” linking back into the inputs of “investor objectives and
constraints” and “real estate market conditions and expectations”, thereby completing a
portfolio management process which is circular in extent.
The extent of the property investment decision making process in terms of content,
however, differs considerably between authors. Such differences are challenging to
consider as it is unclear whether the apparent difference is due to authors describing
different activities or using different terms to describe the same activity. For example, it
is unclear whether the activity of “auditing” described by Brown and Matysiak (2000) is
the same as “portfolio performance measurement” described by Pagliari (1995) or “post
investment activity” described by Roberts and Henneberry (2007).
Similarly, the risk management activities of appraisal and due diligence are specifically
referred to by some authors. Though other authors may not specifically refer to same, it is
not necessarily clear that such activities are excluded by those authors and they may be
included but simply unspecified.
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Accepting the propositions that the property investment decision making process is
sequential and linear in nature and circular in extent, there are clearly a series of phases
comprising the process. The various authors identify a large number of elements in the
property investment decision making process, some of which are common among authors
and some of which vary. The large number of elements identified by various authors may
be grouped as activities which comprise a range of elements occurring close together in a
sequence. Further, the smaller number of activities may then be combined into phases
which comprise a series of activities that require completion before the next phase may
commence.
Brown and Matysiak (2000) adopt a high level phase approach to the capital budgeting
process, referred to above, through classification into phases of screening, evaluation,
implementation and auditing. While the authors acknowledge that this refers to the
capital budgeting process only, the grouping principle may be equally applicable to the
property investment decision making process as described by other authors.
Roberts and Henneberry (2007) proposed a ten step framework based on the literature,
but it may be contended that some of the steps may be combined to create phases. For
example, steps 1 and 2 involve the identification of goals and strategy which comprise a
phase requiring completion before proceeding further. Similarly, steps 4, 5 and 6 involve
different forms of information processing that also comprise a phase requiring
completion before proceeding further. It may be hypothesized, therefore, that the number
of phases in property investment decision making may be fewer than the number of steps
proposed by Roberts and Henneberry (2007).
It is, therefore, proposed to hypothesise a simplified property investment decision making
framework, based on the literature reviewed, that is capable of application by REITs
given their specific characteristics and that may be tested by subsequent empirical
analysis. Viewing the property investment decision making process as a sequential,
linear, circular process comprising a small number of high order phases, it may be
hypothesized that the various elements and activities may be classified into the following
phases:
-
-
© D. Parker 2010
defining the purpose and rationale for the portfolio, which may be
described as the envisioning phase;
determining how the purpose and rationale for the portfolio will be
implemented in practice, which may be described as the planning
phase;
seeking to bring the planning phase into reality, which may be
described as the dealing phase;
converting the planning phase into reality, which may be described as
the executing phase;
monitoring the reality that is the portfolio, which may be described as
the watching phase; and
linking the watching phase back to the envisioning phase through an
active process, which may be described as the optimising phase
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and which may be illustrated graphically in Figure 3.
Mapping the Real Estate Portfolio Management Process
Source: Author (after Pagliari (1995) and Brown and Matysiak (2000))
Figure 3
Such an approach to mapping the property investment decision making process may be
contended to be consistent with the literature surveyed as it reflects a process which is
sequential and linear in nature and circular in extent.
Further, it may be contended that such an approach allows inclusion of each of the steps
identified by the various authors in the literature reviewed. Adopting the step numbers
used by the respective authors, Figure 4 indicates how the steps in the approaches to the
property investment decision making process identified within that literature surveyed
may be reconciled with the phases suggested in Figure 3.
For example, Pyhrr et al (1989) propose a ten step process including:
1. determine the investment strategy;
2. generate alternatives;
3. analyse property using basic financial feasibility models;
4. negotiate basic terms with sellers;
5. do detailed feasibility research;
6. complete financial and tax structuring;
7. perform a DCF analysis;
8. final negotiations and closing;
9. manage the property; and
10. terminate the property.
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While step 1 may be included within the envisioning phase and step 2 in the planning
phase, steps 3, 4, 5, 6 and 7 may be combined in the dealing phase. Thereafter, step 8
maybe included in the executing phase, step 9 in the watching phase and step 10 in the
optimizing phase.
A similar approach may be adopted for the frameworks proposed by other authors with
Figure 4 indicating that the hypothesized phases are potentially capable of
accommodating the various elements and activities identified by the respective authors.
Phase
Envisioning
Planning
Pyhrr et al (1989)
Jaffe and Sirmans
(2001)
1
2
Dealing
3, 4, 5,
6, 7
1
2
3, 4
Pagliari (1995)
1
2, 3
4
1
2, 3
4
2
3
4, 5, 6
2
3
1
2
1
2
9
10
1
2
3, 4
3, 4, 5,
6, 7, 8
3, 4, 5,
6
7, 8
9
1
2
3, 4, 5
6
Roulac (1994)
Baum (2002)
Brown and Matysiak
(2000)
Hartigay and Yu (1993)
Roberts and Henneberry
(2007)
Farragher and Savage
(2008)
Farragher and Kleiman
(1996)
1
1
Executing
Watching
Optimising
8
9
10
5
5, 6
4
5
7
Reconciling the Mapping of the Real Estate Portfolio
Management Process to the Literature Surveyed
Source: Author
Figure 4
Interestingly, Figure 4 indicates that, on the basis of the approach adopted by the majority
of authors, the majority of steps are taking place in the dealing phase, being the
conversion of the planning phase into reality. Based on that literature surveyed, this phase
includes a range of analytical and modeling activities including feasibility research, risk
return forecasting, DCF analysis and modeling.
It is unclear, without further analysis, whether the greater focus on the dealing phase is
because there are a much larger number of activities to be undertaken in this phase,
whether this phase has been subject to greater analysis than other phases, whether this
phase forms a greater part of the teaching curriculum in tertiary courses and so comprises
a larger portion of text books or for other reasons yet to be identified.
Accordingly, the property investment decision making process may be contended to be
sequential and linear in nature and circular in extent with identifiable phases but with
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further research required to specify the content of each phase and the applicability of the
process by REITs, given their distinct characteristics such as the requirement for
continuous disclosure.
5.0
Role of Judgment
Roberts and Henneberry (2007) note that the textbook and journal paper authors
generally approach the property investment decision making process as a normative
model, being an exercise in rational analysis with a dependence on the use of rational
evaluation tools such as modern portfolio theory and the capital asset pricing model to
inform decision making. This characterizes the property investment decision making
process as fundamentally quantitative with decision rules that are essentially numeric or
financial and limited space for qualitative input or judgmental, subjectively based
decision rules.
Alternatively, Farragher and Savage (2008) refer to good real estate investment decision
making being based on the application of experience, good judgment and creativity,
suggesting a role for qualitative input and judgmental, subjectively based decision rules.
Within the phases proposed in Figure 3, it may be hypothesized that each phase may
accommodate both quantitative, objective elements and qualitative, subjective elements.
For example, bringing the planning phase into reality through the dealing phase may
combine quantitative analysis, modeling and numeric decision rules with qualitative
negotiation. Accordingly, further research is required to investigate the extent to which
each phase may comprise quantitative, objective elements and qualitative, subjective
elements.
Significantly, however, as Roulac (1994) notes, decision making in an institutional
setting, such as exists in the publicly listed REIT environment, should emphasise process.
How the fiduciary responsibility of REITs might be reconciled with the potential use of
judgment through qualitative, subjective elements in the property investment decision
making process also requires further research.
6.0
Conclusions and Areas for Further Research
Considering the massive size of the global REIT market, surprisingly little research has
been undertaken into REIT property investment decision making.
From the literature surveyed, it is evident that the property investment decision making
process is complex, non-standardised and potentially lacking in transparency.
While the property investment decision making process may be contended to be
sequential and linear in nature and circular in extent with identifiable phases,
considerable further research is required to both determine the appropriateness of
classification into phases and to specify the content of each phase.
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Further research is also required concerning the extent to which the steps within each
phase may be either omitted or undertaken in a different sequence together with the
possible impact of same on the resulting decision.
Similarly, further research is required to determine the extent of difference, if any,
between generalized property investment decision making frameworks for institutions
and those adopted by REITs to reflect their differing characteristics, such as the
environment of continuous disclosure.
Such research may include a survey of the journal literature concerning specific elements
in detail, based on which the decision making framework hypothesized above may be
refined and restated. The restated decision making framework could then be tested
through empirical research, such as REIT manager interviews, to determine the extent to
which the hypothesized decision making framework adequately describes the process
adopted in practice.
6.0
References
Baum, AE (2002) Commercial Real Estate Investment, Estates Gazette, London
Block RL (2002) Investing in REITs, Bloomberg Press, Princeton
Brown GR and Matysiak GA (2000) Real Estate Investment: A Capital Market
Approach, Financial Times Prentice Hall, Harlow
Farragher EJ and Kleiman RT (1996) A Re-Examination of Real Estate Investment
Decisionmaking Practices, Journal of Real Estate Portfolio Management, Vol 2,
No 1, pp31-39
Farragher EJ and Savage A (2008) An Investigation of Real Estate Investment DecisionMaking Practices, Journal of Real Estate Practice and Education, Vol 11, No 1,
pp29-40
Garrigan RT and Parsons JFC (Editors) (1997) Real Estate Investment Trusts, McGraw
Hill, New York
Geltner DM, Miller NG, Clayton J and Eichholtz P (2007) Commercial Real Estate
Analysis and Investment, Thomson South-Western, Mason
Hartigay S and Yu S-M (1993) Property Investment Decisions: A Quantitative Approach,
E&FN Spon, London
Jaffe A and Sirmans CF (2001) Fundamentals of Real Estate Investment, South Western
Thomson Learning, Mason
Pagliari, JL (Editor) (1995) The Handbook of Real Estate Portfolio Management, Irwin,
Chicago
Pyhrr SA, Cooper JR, Wofford LE, Kapplin SD, and Lapides PD (1989) Real Estate
Investment: Strategy, Analysis, Decisions, John Wiley and Sons, New York
Radanovic D and DeFrancesco A (2008) Global REITs – Key Features and Recent
Trends, IPD Research, Melbourne
Roberts C and Henneberry J (2007) Exploring Office Investment Decision Making in
Different European Contexts, Journal of Property Investment and Finance, Vol
25 No 3, pp289-305
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Roulac SE (1994) The Evolution of Real Estate Decisions, in De Lisle and Sa-Aadu
(Editors), Appraisal, Market Analysis, and Public Policy in Real Estate, Kluwer
Academic Publishers, Norwell
Wurtzebach CH, Miles ME and Cannon SE (1994) Modern Real Estate, John Wiley &
Sons, New York
0110_PRRES_ PrInvDecMkg.doc
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